Wednesday, September 22, 2010

Thanks to 2.5% yields on 10-yr Treasuries and the ongoing improvement in the efficiency and liquidity of the mortgage-backed securities market (which has resulted in a tightening of the spread between conforming and jumbo rates), homebuyers today can take advantage of the lowest 30-yr fixed-rate mortgages in history, whether for a conforming or a jumbo loan.

One reason rates are so low is that demand for mortgage loans is also relatively low, as reflected in the above chart, which shows a measure of all mortgage applications for the purchase of a single-family home. The volume of new mortgage applications has fallen significantly since the peak of the housing market in 2005, but I note that the current volume is still higher than pre-1997 levels. Things have really cooled off, but they haven't ground to a halt by any means.

The other reason for low rates is that demand for high-quality yield is very strong. Investors are willing to accept 2.5% yields on 10-yr Treasuries and 3.4% yields on MBS because they worry about the ability of alternative investments to do better on a risk-adjusted basis. As I've noted before, the last time yields were this low for any meaningful period of time was in the late 1930s and 40s, when investing attitudes were powerfully shaped by depression and deflation.

Looking at both sides of the mortgage equation thus reveals great fear and uncertainty about the future: homebuyers worried that prices might fall further, and investors worried that the entire economy is at risk of a double-dip. That's one more reason to believe there is a lot of bad news that has been priced into today's market. This affords the investor an excellent cushion, since the mere absence of bad news ends up being a positive for prices.